Performance Evaluation of Collective Investment Schemes in Ghana

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1 International Journal of Empirical Finance Vol. 3, No. 4, 2014, Performance Evaluation of Collective Investment Schemes in Ghana Abubakar Musah 1 Abstract The performance of collective investment schemes (CISs) provides investors with an opportunity to know how well or otherwise CISs perform before choosing a CIS to invest in. Raw returns are usually reported by CIS managers in Ghana, mostly in their annual reports. However, higher raw returns do not necessarily reflect superior performance. A risk adjusted performance measure can better reflect the performance of a collective investment scheme. This study therefore evaluated the performance of ten CISs in Ghana in terms of average returns and on a risk adjusted basis using the classic approaches the Sharpe ratio, the Treynor index and the Jensen alpha over the period It also compared the performances of equity, money market and balanced CIS over the period. Data were hand collected from CIS reports. The results showed that CISs in Ghana have performed poorly over the period across the three performance measures. The balanced funds performed better than the money market and equity CISs. Keywords: performance evaluation, collective investment schemes, Treynor index, Jensen alpha, Sharpe index 1. Introduction Since the last thirty years or so, the popularity and interest in collective investment schemes (CISs) has grown tremendously and many researchers have attempted to evaluate performance and other related aspects of CISs around the world. These studies aimed at providing information for various stakeholders of this multi trillion dollar industry. The evaluation of the performance of collective investment schemes has been done by several researchers, most of whom are in the US and Europe. However, not much has been done on the Ghanaian market. Raw returns are usually reported by CIS managers in Ghana, mostly in their annual reports. However, higher raw returns do not necessarily reflect superior performance. As shown by Jenson (1968), even an unskilled manager can increase raw returns by undertaking highly risky investments. Only a risk adjusted performance measure can truly reflect the performance of a collective investment scheme. The CIS market in Ghana is still young and small with a little over 30 funds available in the market. Fund sizes and numbers continue to increase annually despite numerous challenges faced. Most investors in Ghana are not sophisticated enough to make financially prudent decisions except those based on hearsay. The herding behavior theory is observable in this case. There are no rating agencies to rank the CISs based on their risk adjusted performances and hence investors are forced to make decisions based on raw returns presented in annual reports of CISs. It is therefore essential to examine the performance of the CISs in Ghana to help fill the knowledge gap. Several risk adjusted performance measures have been proposed and used in the literature by other researchers. This study therefore applied some of the performance measures to find out how the CISs in Ghana perform on a risk-adjusted basis. The paper further compared the performances of equity based CIS, money market based CIS, and balanced CIS in Ghana. 1 Department of Finance, University of Ghana Business School, Legon Accra 2014 Research Academy of Social Sciences 202

2 2. Literature International Journal of Empirical Finance The capital asset pricing model developed in the 1960s independently by Sharpe (1964) and Lintner (1965) provided financial economics with an opportunity of evaluating the performance of CIS on a risk adjusted basis. Prominent amongst them is Jensen (1968), who developed a risk-adjusted measure of the performance of managed portfolios relative to a single market-index benchmark. He first developed a way of determining the ability of portfolio managers to add returns in excess of the risk free rate and the risk premium. His analyses showed that there was very little evidence that any individual fund could do significantly better than that which was expected from mere random chance. Hence, managers of the funds were not smart enough. Artikis (2003) evaluated the performance of ten balanced mutual funds in the Greek Financial Market. Artikis used the techniques of Treynor, Sharpe and Jensen to rank the ten mutual funds he considered. In ranking the mutual funds, Artikis also considered the return, total risk, systematic risk, and the coefficient of variation. Artikis found out that all the ten domestic balanced mutual funds participating in the research achieved lower return than the return of the General Index of the ASE over the evaluation period. Robert and Anandi (1988) found out that the effect of the size of a mutual fund on its total return can be measured using the relationship of the fund s net assets and return. They also concluded that small mutual funds are doing better than big mutual funds in the US. According to them, this is due to the fact that small mutual funds exhibit significant positive risk. Gorman (1991) found the same results as mentioned by Robert and Anandi (1988) that small mutual funds (mostly measured by their net assets) perform in most cases faintly better than large mutual funds. Another important basis mentioned by Gorman (1991) was that most of the mutual funds swiftly wear out the economies of scale leading to decline in returns. According to Glenn and Patrick (2004), open ended CISs need more cash assets than close ended CISs because they face a possibility of redemption; so it also means that open ended CISs have less money investments leading to low returns. George and Kevin (2009) developed a measure of performance evaluation, the generalized Sharpe ratio, by combining the Sharpe ratio and the second order stochastic dominance (SSD). According them, the generalized Sharpe ratio provides a complete rank of funds and is also consistent with investors risk aversion. When the generalized Sharpe ratio was tested with a sample CIS, the results showed that the ranks based on the new measures can be very different from those based on the conventional Sharpe ratio. Sharpe (1966) argued that non-systematic risk cannot be fully distributed by mutual funds. Therefore, mutual fund performance evaluation should be based on the adjustment of the excess returns on the portfolio under consideration of total risk as a performance measure. The standard deviation of the portfolio returns will therefore capture both systematic and non-systematic risks. Li Chang Hsu et al (2012) evaluated the performance of mutual funds in Taiwan and found that different performance measures led to significantly diverging rankings of mutual funds in different market climates (that is a market moving from a bull period to a bear period). They tried to find an appropriate performance measure in situations where the market reverses back from a bull period to a bear period. Dıaz Mendoza et al (2012) examined the impact of how expenses are charged on the performance of equity CIS. They showed that performance based fee CISs perform significantly better than the other risky CISs considered. Also, a strong positive relationship was found between performance and expenses in performance based fee CISs than asset-based fee CIS. These results, according to them, seem to indicate more efficient management in performance based fee CISs, in contrast with their low presence in the CIS industry. Barber et al (2000) analyzed the purchase and sale decisions of mutual funds of over 30,000 households in the U.S over a period of six years. Two findings were made; firstly, investors buy funds with strong past performance. More than half of the fund purchases occurred in funds ranked in the top quintile of past annual returns rankings. Secondly, investors sell funds with strong past performance and are reluctant to sell their losing fund investments. According to their findings, mutual fund investors are twice more likely to sell a winning fund than a losing fund. These findings could mean that high performing funds experience changes in ownership than low performing funds. The introduction of risk could however change the picture since high performing CIS in terms of raw returns might have taken more risk. A risk adjusted ranking would be more appropriate and could tell the story better. Robert (1970) found out that the question of 203

3 A. Musah whether or not funds outperform the market is to a large extent a function of both the time period used and the proxy selected to represent the market. This means that different benchmarks and time periods will show different results. Following on the model developed by Jensen (1968) to measure the skills of managers, several multi factor models have been proposed by other researchers. The Jensen alpha measures performance using a single measure of risk (exposure to the market). The researchers who followed proposed other forms of risk that a portfolio could be exposed to. They include the model proposed by Fama and French (1992, 1993), Carhart (1997), and Elton, Gruber and Blake (1996). Conditional performance evaluation models have also been proposed by researchers such as Ferson and Schadt (1996) and Christopherson, Ferson and Glassman (1998). However, this paper will not use these models since data needed to use the other models are nearly unavailable in the Ghanaian context. 3. Methodology Average annualized monthly returns were used to estimate the non risk adjusted performance of the collective investment schemes. For each CIS, the annualized monthly return was compared to the average annualized monthly return of the GSE CI. Despite the criticisms of the Treynor index, the Jensen alpha, and the Sharpe ratio, they remain the most widely used in the finance literature. Besides, data on the Fama French factors and the conditional performance evaluation techniques are not available in the Ghanaian context. These three measures are therefore appropriate to use, especially in Ghana where there is little literature on the risk adjusted performance of CISs. This study therefore evaluated the performance of the collective investment schemes in Ghana using these three classic performance measures. Sharp Ratio It is the ratio of the average excess returns on a portfolio to the standard deviation of the portfolio. The Sharpe index measures risk using the standard deviation of the returns on the R p R f SI Collective investment scheme. p (1) Where SI = Sharpe Index, p standard deviation of the portfolio, R p = Average annualized monthly return on the portfolio over the evaluation period, and R f = Average Risk free rate of return over the evaluation period. A higher Sharpe ratio means that the fund is able to earn a greater return for its level of volatility. The Sharpe ratio assumes constant risk over time. The average excess returns for each fund was computed by subtracting the average Treasury bill rate over the evaluation period from the annualized monthly return of the fund. The figure obtained was then divided by the standard deviation of the returns of the fund to obtain the Sharpe ratio. Treynor Index The Treynor index is the ratio of the average excess returns on a portfolio to the beta of the portfolio. It uses beta as a measure of risk. It is given as: R P R f TI p (2) 204

4 Where = beta of the fund, International Journal of Empirical Finance R p = Average annualized monthly return on the portfolio, and R f = Average risk free rate of return. The higher the Treynor index, the greater the excess return earned per unit of systematic risk, and the better the fund s performance. Just like Sharpe, Treynor also assumed that risk is constant over time. A constant risk means that the beta of the portfolio is constant over time. Similar to the Sharpe ratio, the Treynor index for each fund was obtained by dividing the average excess returns by the beta of the fund. The average excess returns for each fund was computed by subtracting the average Treasury bill rate over the evaluation period from the annualized monthly return of the fund. The denominators differentiate the two risk-adjusted measures from each other. It is important to note that Sharpe (1966) and Treynor (1969) used arithmetic means of the portfolio returns and also for the return on the risk free asset. Jensen Alpha (Unconditional alpha) The Jensen alpha is a measure of absolute performance on a risk-adjusted basis unlike the Treynor and Sharpe Indexes. It measures the excess of a portfolio s return over the required rate of return as determined by the Capital Asset Pricing Model (CAPM). An OLS estimation of the regression below is run to find the alpha and the beta: R R R R (3) p, t f, t p p m, t f, t p, t R p, t is the return on portfolio, p, at time, t. day treasury bill is used). Performance of equity, balanced and money market CISs R, is the return on risk free asset (for this study, a 91 f t To compare the performances of the different types of CISs (equity, balanced and money market), three separate panel regressions of the Jensen (1968) model were run for each fund type and their alphas compared. A simple average of the computed Sharpe ratios and Treynor Indices for balanced funds, equity funds and money market funds were also compared to determine which CIS type is doing better. In other words, the simple average of the Sharpe ratios and Treynor indices of the two balance funds was computed and compared to the simple average of the equity funds as well as the money market funds. 4. Discussion of Findings The three classic measures of risk adjusted performance of CISs were computed; the Sharpe ratio, the Treynor index and the Jensen alpha. Sharpe Ratio (return to variability) The Sharpe ratio brings together the benefits and risks of investment into one performance measure. The results of the Sharpe ratio show that three CISs were not able to outperform the market. Table 1 below presents the results of the Sharpe ratio computed from the returns of the CISs over the period : 205

5 A. Musah Table 1: Sharpe Ratios Computed Over the Period CIS Mean (%) Mean Excess Returns (%) σ p SR Fund Type Fund Equity Fund Equity Fund money market Fund Balanced Fund Balanced Fund Equity Fund Equity Fund Equity Fund Equity Fund money market AVERAGE GSE-CI R f Source: Author s computations Fund 8, fund 9 and fund 10 recorded the worse Sharpe ratios of -1.92, and respectively. The rest of the CISs however performed better than the GSE CI which recorded a Sharpe ratio of The best performing CIS over the study period was fund 1 with a Sharpe ratio of 0.62 whiles the worst performing CIS was fund 9 with a Sharpe ratio of The average Sharpe ratio of the ten CISs used for the study during the study period was which is higher than that of the benchmark index. This means that, on average, the CISs in Ghana have performed better than the GSE CI on the basis of the Sharpe ratio over the evaluation period. Not all the CISs were able to outperform the benchmark index (GSE CI) individually on the basis of the Sharpe ratio (return to variability) for the period Out of the 10 CISs, only 2 CISs representing 20% were able to record positive Sharpe ratios. This is due to the inability of most of the CISs in Ghana to earn positive annualized monthly returns in excess of the risk-free rate. The average risk free rate for the period was 16.10% compared to the highest average CISs return of 17.94% for the period The CISs in Ghana have performed poorly over the study period. They have shown high variability in their returns since the standard deviations (total risk) over the study period were high. Treynor Index (return to volatility) Table 2: Treynor Index Computed Over the Period CIS Mean (%) Mean Excess Returns (%) Β TI Fund type Fund Equity Fund Equity Fund money market Fund Balanced Fund Balanced Fund Equity Fund Equity Fund Equity Fund Equity Fund money market Average GSE CI R f Source: Authors computations 206

6 International Journal of Empirical Finance Similar to the Sharpe ratio, the Treynor index is negative for eight of the ten CISs and also negative for the benchmark index (GSE CI). This is due to the inability of the CISs to earn monthly returns in excess of the risk-free rate as stated before. Table 2 below presents the results of the Treynor Index computed from the returns of the CISs over the period : As table 2 above shows, fund 2 recorded the highest Treynor Index of 5.21while the worse performing CIS was fund 10 with a Treynor Index of All the CISs recorded higher Treynor Indices than the benchmark index, which recorded a Treynor Index of The average Treynor Index for all the CISs was -3.37, which is higher than that of the GSE CI, again suggesting that on average the CISs in Ghana have performed better than the GSE CI on the basis of the Treynor index. Apart from fund 9 and fund 10, all the CISs maintained their rankings as it is in the Sharpe ranking. Jensen Unconditional Alpha The Jensen (1968) alpha for the period was negative and significant for most of the CISs indicating that managers were not able to earn superior returns for the investors. They rather earn negative additional returns for the investors over the study periods. The negative alphas suggest that the CIS managers performed poorly over the study period. A passive investor could earn better returns than that offered by the collective investment schemes in Ghana. Table 3 below presents the results for the Jensen (1968) model. Table 3: Jensen Alphas Estimated Over the Period CIS α p β p ADJ. R 2 Fund Type Fund * 0.234* Equity (8.354) (4.522) Fund * 0.322* Equity (4.401) (4.96) Fund * 0.240* money market ( ) (5.316) Fund * 0.258* Balanced (-8.844) (4.654) Fund * 0.324* Balanced (3.082) (5.615) Fund * 0.194* Equity (-8.550) (3.00) Fund * 0.262* Equity (-8.967) (4.672) Fund * 0.310* Equity (-2.125) (4.973) Fund * 0.241* Equity ( ) (5.044) Fund * 0.333* money market (-1.694) (6.726) Average * 0.272* (-2.937) (5.469) 5% (t-statics in brackets), Source: Authors computations As table 3 shows, the best performing CIS on the basis of the Jensen (1968) alpha was fund 1 with a statistically significant alpha of while the worst performing CIS on the basis of the alpha is the fund 9 with a statistically significant alpha of The average alpha for all the funds was % of the funds performed better than the average performance of all the ten CISs whiles the other 50% performed worse than the average of all the CISs on the basis of the Jensen alpha. 207

7 A. Musah According to Jensen (1968), the alpha value indicates the stock selectivity of the fund managers, an aspect of performance not captured by the reward to risk ratio measures proposed by Sharpe (1966) and Treynor (1969). Have the CISs in Ghana over the years demonstrated stock selection skills? The alpha values suggest that only 30% of the CISs have stock selection skills while the majority of them, representing 70%, do not show stock selection skills. On average, the CISs do not show superior stock selection skills as the alphas show in Table 3. Only three, namely fund 1, with an alpha of 3.626, fund 2 with an alpha of and fund 5 with an alpha of 0.48, representing 30% of the ten CISs recorded statistically significant positive alpha values. The positive values mean that the activities or decisions of the managers improved the returns of the CISs for the investors. The other seven CISs, representing 70% of the ten CISs recorded statistically significant negative alpha values, which mean that the activities or decisions of the managers worsened the returns of the CISs. The ranking of the sample CISs varied to some extent among the techniques proposed by Treynor, Sharpe and Jensen. However, certain CISs were ranked in the same order regardless of the technique used. Table 4 below shows the ranking of all the CISs based on the average monthly returns, Sharpe ratio, the Treynor index and the Jensen alpha: Table 4: Collective Investment Schemes Rankings Based On Different Performance Measures Cis Average Returns Sharpe Ratio Treynor Index Jensen Alpha Fund Fund Fund Fund Fund Fund Fund Fund Fund Fund Source: Authors ranking (based on computed indices), 1 = best and 10 = worst Table 4 shows that only one CIS (fund 8) recorded a consistent ranking under all the four performance evaluation techniques. Three CISs (fund 3, fund 4 and fund 5) achieved the same rankings under three different performance measures (average monthly returns, Sharpe ratio and the Treynor index). A well-diversified portfolio should be able to reduce the unsystematic risk and get the total risk closer to the market risk. Systematic risk is the risk due to the movement of the market itself. Unsystematic risk is the risk of one company causing a significant move either up or down- in a portfolio. This is usually the risk that most (risk averse) investors would want to eliminate - unless they are true risk takers (few are). It may be tempered - and in fact virtually eliminated - by the purchase of a certain number of stocks or bonds. One way of examining the degree of diversification of investment portfolios, though one not normally monitored except by certain portfolio managers and sophisticated investors who statistically monitor various funds, is the R squared which measures the variation of portfolio returns explained by the market. It's an indication of a fund's overall diversification and measures the percentage of the fund s performance as compared to the overall market. As shown in column 4 of table 3, the highest R 2 is 55.1% while the lowest R 2 is 35.1%. The average R 2 for all CISs is about 48% which suggests the degree of diversification of CISs portfolios is low. This means that the CISs are 48% as diversified as the GSE CI. Performances of Equity, Balance and Money Market Funds One of the objectives of the study is to compare the performances of the three types of CISs, equity, balanced and money market CISs. The average Sharpe and average Treynor indices are presented below. To compare manager performances of the balanced, equity and money market CISs, three separate panel 208

8 International Journal of Empirical Finance regressions were also run for the equity CISs, balanced CISs and the money market CISs. Table 5 below presents the result of the three risks adjusted performance measures for the three types of funds. The figures in parentheses for the alpha and the beta are the t statistics: Table 5: Performances of Equity, Balanced and Money Market Ciss Money Market Balanced Equity AVR. SHARPE AVR. TREYNOR ALPHA, α * 0.061* * (-8.498) (5.717) ( ) BETA,β 0.287* 0.291* 0.260* (8.53) (7.308) (11.012) ADJ. R % (t-statics in brackets), Source: Authors computations The alphas show that two of the three types of funds have experienced negative abnormal performances suggesting that the decisions of the managers have worsened the performance of the CISs. However, the balanced funds achieved a positive value with the highest alpha of The worst performing type of funds on the basis of the Jensen (1968) unconditional model were the equity funds with the lowest alpha of %. The balanced funds have performed better than the other two types of funds under all three performance measures. The average Sharpe ratio is and the average Treynor index is which is higher than those of the other fund types. However, the average Treynor indices and Sharpe ratios are based on small samples and therefore are limited in value. They should therefore be interpreted carefully. 5. Conclusions This work examined the performance of collective investment schemes in a very infant market. The study revealed very low performance of the CISs in Ghana over the period The results and discussions revealed that, in terms of average returns, CISs have outperformed the market benchmark (GSE CI). However, the CISs have not been able to earn returns in excess of the risk free asset (91 Day Treasury bills). This means that the investor would be better off investing in the risk free asset. Three risk adjusted measures were used; the Sharpe ratio, the Treynor index and the Jensen alpha. Majority of the CISs performed better than the benchmark (Ghana Stock Exchange Composite Index) after adjustment for total risk (Sharpe ratios) and also systematic risk (Treynor index) even though most of them achieved negative values for the Sharpe and the Treynor indices. The CISs do not also hold well diversified portfolios. Many of the funds appeared not well managed as evidenced by the negative Jensen alphas achieved by the managers of the CISs. For instance, it may be misleading to conclude that actions of managers of the CISs resulted in negative superior returns. These results could be due to market illiquidity. An illiquid market can limit the extent of diversification achieved which therefore provides misleading results for Jensen alpha and Sharpe ratio. Three panel regressions for the equity, balanced and the money market CISs showed that the balanced CISs performed better than the other two fund types as it was the only fund type with a positive Jensen alpha. Though both achieved negative Jensen alphas, the money market CISs performed better than the equity CISs. On the basis of the Sharpe ratio and the Treynor index, the balanced funds again did better than the other two fund types as the balanced funds achieved the highest average Sharpe and Treynor indices. Overall, the CISs have performed unsatisfactorily across all the performance measures used for this study. This paper recommends more investor education as funds under CIS management continues to increase despite the abysmal performances. 209

9 References A. Musah Ali, R. & Qudous, R. A. (2012). Performance Evaluation of Mutual Funds in Pakistan. Interdisciplinary Journal of Contemporary Research in Business, 3(9), Artikis, G. P. (2003). Performance evaluation: a case study of the Greek balanced mutual funds. Managerial Finance, 29(9) 1 8 Barber, B. M., Odean, T. and Zheng, L. (2000). The Behavior of Mutual Fund Investors. unpublished paper, University of California and University of Michigan, USA Carhart, M. (1997). On Persistence in Mutual Fund Performance. Journal of Finance, 52, Christopherson, J. A., Ferson, W. E. and Glassman, D. A. (1998). Conditioning Manager Alphas on Economic Information: Another Look at the Persistence of Performance. The Review of Financial Studies Spring, 11(1), D ıaz-mendoza, A. C., L opez-espinosa, G. and Mart ınez, M. A. (2012). The Efficiency of Performance Based Fee Funds. European Financial Management, 2012, doi: /j X x Elton, E. J., Gruber, M. J. & Blake, C. R. (1996). The Persistence of Risk-Adjusted Mutual Fund Performance. Journal of Business, 69(2), Fama, E. F. and French, K. R. (1992). The Cross Section of Expected Stock Returns. Journal of Finance, 47, Fama, E. F. and French, K. R. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, 33, 3 56 Ferson, W. E. & Schadt, R. W. (1996). Measuring Fund Strategy and Performance in Changing Economic Conditions. Journal of Finance, 51, George, J. J. and Kevin, X. Z. (2009). Generalized Sharpe Ratios: Performance Measures Focusing on Downside Risk. International Research Journal of Finance and Economics, 30, Glenn, B. J. and Patrick, T. (2004). The mechanics behind investment funds: why closed-end funds provide superior returns, Managerial Finance, 30(12), Gorman, L. (1991). A Study of the Relationship between Mutual Fund Return and Asset Size Akron Business and Economic Review, 22, Jensen,M. C. (1968). The Performance of Mutual Funds in the period Journal of Finance, 23(2) Li-Chang, H., Shang-Ling, O., Chia-Chen, Y. and Yih-Chang, O. (2012). How to Choose Mutual Funds that Perform Well? Evidence from Taiwan. International Journal of Economics and Finance, 4(1), Lintner, J. (1965). The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets. Review of Economics and Statistics, 47(1), Mensah, S. (2008). Securities Markets and Investments: A Ghanaian Primer. Smartline Limited, ISBN: Robert, S. C. (1970). Aggregate Performance of Mutual Funds The Journal of Financial and Quantitative Analysis, 5(1), 1 32 Robert, T. K. and Anandi P. S. (1988). The relationship between Mutual Fund size and risk-adjusted performance: An analysis of load funds. American Business Review, 6(2), 26 Sharpe, W. F. (1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. The Journal of Finance, 19(3), Sharpe, W. F. (1966). Mutual Fund Performance. Journal of Business, 39,

10 International Journal of Empirical Finance Treynor, J. L. (1965). How to Rate Management of Investment Funds. Harvard Business Review, 43,

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